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Krugman’s Latest Comment on MMT

In a recent post, “Franc Thoughts On Long-Run Fiscal Issues”, Paul Krugman has once again engaged with MMT. His main argument this time concerns the difference, if any, between issuing debt when deficit spending rather than simply allowing balances to mount in reserve accounts. He agrees that under current circumstances zero interest short-term debt and zero-interest reserves are close substitutes, but argues that issuing debt and allowing reserves to mount will have different inflationary implications when interest rates are positive.

He writes:

The composition of public liabilities as between debt and monetary base does matter in normal times — hey, if it didn’t, the Fed would have no influence, ever. So if we try at that point to finance the deficit by money issue rather than bond sales, it will be inflationary.

The MMT position is that if the interest rate target is positive, short-term debt would remain a close substitute to reserves provided the Fed paid the equivalent interest rate on reserves. This would be the most straightforward approach to monetary policy: simply to pay interest on reserves at the target rate rather than issuing short-term debt.

Nevertheless, MMT is in agreement with Krugman that if the Fed did not pay the target rate on reserves, then allowing reserves to mount rather than issuing debt would have a different inflationary impact. Doing so would cause the interest rate to fall to the rate paid on reserves (possibly zero). In that case, reserves would not be close substitutes for short-term debt, and the inflationary implications would be somewhat different.

Even so, the MMT position is that any difference in inflationary impact would be due to the difference in interest rates paid on reserves and short-term debt, and not influenced by the quantity of reserves. This is because MMT rejects the money-multiplier reasoning. It is argued that there is no predictable relationship between the so-called monetary base (currency plus reserves) and the broader money supply (currency plus private demand deposits), and further that since loans create deposits, expansion of the broader money supply is neither constrained nor driven by the base.

This relates also to Krugman’s suggestion that if MMT were correct, “the Fed would have no influence, ever.” Although MMT does in fact suggest that monetary policy effects are less certain and weaker than fiscal policy, there is no suggestion that there can be no impact. Rather, the impact can only be through price (interest rates), not quantity (e.g. of reserves). In short, if reserves pay the same interest rate as short-term debt, the inflationary implications will be virtually identical. So, again, MMT suggests the best approach would be to pay the target rate on reserves, obviating the need for debt.

It is encouraging to see Krugman continue to engage with MMT. Right now, the public debate often seems to be bordering on the insane. Krugman is one of the few prominent voices advancing sensible policy responses to the crisis. As he mentions:

… for the time being the MMT people and yours truly are on the same side of the policy debate.

And with everything that is currently going on in the world, the time being is a pretty important time to be, and to try to be heard.

44 thoughts on “Krugman’s Latest Comment on MMT”

Peter, great to see you back, missed your voice.
Now, we’ve been discussing this on PRAGCAP.com and arrived so far at the following real distinction between Krugman and MMT. First, there is no doubt that there is no difference between interest paying reserves and same interest paying bonds – they are functionally the same (almost; bonds can be bough by public, while reserves stay in the banking system, but this is hardly the matter here.)
We also agree that the Fed controls the short term and even the long term nominal rates. The question is what happens to the real rate and if this rate is observable. Suppose a lot of people expect high inflation. They won’t hold the base – because it devalues – and they won’t hold the bonds if we assume that the Fed sets the nominal rate too low. Game over.
If, OTOH, the Fed sets the nominal rates high enough, we’re still in an inflationary spiral due to interest alone. Game over, again.

You say:Even so, the MMT position is that any difference in inflationary impact would be due to the difference in interest rates paid on reserves and short-term debt, and not influenced by the quantity of reserves.

The French episode is controversial. The Central Bank looks like it wanted the Gold Standard back and the Treasury was more flexible. It looks like they were at loggerheads and there were several interventions.

It was not as ‘pure’ a floating currency episode as it is ordinarily depicted.

Not been able to find out what the French owed to America in war debt, or what it was denominated in.

Maybe I am confused, but it seems to me there is another difference between K and MMT as alluded to by heteconomist: Krugman sees a fundamental difference between (interest-paying or not) reserves and bonds, because reserves may be used in the multiplier effect, they can be lent out (or so he thinks), and hence the inflation! It seems to me that he believes in an automatic Pavlov effect on the part of banks: “have reserves -> lend!”. Most economists implicitly believe that.

Neil, Krugman’s assumption from the get-go is that taxation ability is impaired, and that this could be the case for the US. This is a political argument, not an economic one. And MMT agrees – if you cannot tax as much as needed you’re screwed. So, this is not the crux of the difference between PK and MMT.

Let’s not forget that this debate is essentially between monetarism is and fiscalism. Once the French objection is dispatch there will be endless more. The argument need to cut to the chase by showing how monetarism is wrong in its assumption about consequences of interest rates and the quantity of “money” (monetary base), and that the real issue is effective demand in relation to the capacity of the economy to meet it. If effective demand is too low, then economic underperformance and rising unemployment will result. If effective demand is to great for the economy to expand to meet it, then inflation will result. According to MMT, the most effective and efficient way to adjust effective demand is by fiscal operatons that affect non-government net financial assets. This the way to achieve full employment and price stability, which monetarism thinks is impossible because of the so-called natural rate of unemployment, now projected to be possibly be at around 6-8%.

Krugman’s point that taxation is politically impaired is beside the point. We are arguing economics, not politics. If we are go by the prevailing politics, we might as well all just roll over and submit to the dominant paradigm, even though it is grossly in error.

Right, Ron T, there is the hot-potato of reserves that Sumner also talks about. And what Krugman referred to when he talked about the willingness to hold base vs. holding the bonds. And some interest rate the equilibrates the two. And MMT denies there is such an interest rate or that we can observe and act on it. I think this is the crux of the matter, no?

I agree with Ron T that Krugman appears to accept the money-multiplier view and that this is a further cause of disagreement. Believing in the money-multiplier mechanism implies a transmissions mechanism from reserves to prices which simply does not exist in a modern monetary system, as increasingly appears to be recognized by orthodox monetary economists (e.g. at the BIS).

At the same time, I think Peter D is correct to identify the debate over interest as a fundamental cause of much of the disagreement in macroeconomics. The orthodoxy continues to believe in a real determination of interest rates, whereas economists in the Post Keynesian tradition have long argued that interest has a monetary determination.

I tried to discuss some of these differences previously, although my discussion was very far from complete:

The MMT position is that the central bank can control nominal rates and fiscal policy is most effective at controlling the general price level, especially through intelligent use of automatic stabilizers which, once instituted, are not prone to the same political obstacles as changes in discretionary measures. To the extent inflationary expectations respond to ongoing price stability, control of nominal rates also translates into strong influence over real rates.

But there is also disagreement over the significance of real rates of interest. For neoclassicals, they are an important determinant of private investment and hence demand, whereas Post Keynesians consider the effects of interest rates on demand ambiguous and their significance primarily distributive. Demand expectations are regarded as the driver of investment. This is because strong demand translates into strong profits, on the basis of the Kalecki profit equation. Interest is simply a share of income out of gross profits.

Good comment, Tom. Many heterodox economists have indeed been engaged in an intense debate over interest and money, especially since Keynes, and Post Keynesians in particular debated strongly against the monetarists. Someone like Ramanan could probably write a lot about that. Kaldor, for instance, contributed a terrific book (The Scourge of Monetarism). A big source of frustration has been that Keynes’ insights were twisted (and Kalecki’s largely ignored) by the dominant orthodoxy; the capital debates were swept under the carpet (it is exceedingly problematic to maintain the notion of a real determination of interest in light of those debates); and now the implications for causation of MMT’s insights on monetary operations (e.g. that expansion of reserves cannot cause private bank lending) are being similarly ignored or misunderstood.

Krugman is making a more basic mistake than is being cited. Krugman’s whole liquidity trap argument is predicated on the loanable funds market and the multiplier myth.

Furthermore, he assumes that the government doesn’t have control of the yield curve. This is a false idea. As long as we pay IOR the Fed controls rates. This will maintain short bonds as good cash substitutes.

Krugman is making a bigger error in his thinking here than most assume.

“Doing so would cause the interest rate to fall to the rate paid on reserves (possibly zero). In that case, reserves would not be close substitutes for short-term debt, and the inflationary implications would be somewhat different.”

If the reserve position is such that the policy rate converges to the interest rate paid on reserves, then arbitrage will ensure that the short term debt rate will also converge to the rate paid on reserves.

The inflationary implications from a conventional monetary policy perspective will depend on what that convergence level is.

This isn’t much of a material issue where the interest on reserve regime is of the corridor type.

Where it becomes pathological is when the interest rate paid on reserves is zero and the policy rate is materially positive. But that’s a nonsensical case in this context, since policy ensures that the reserve supply is binding for the trading level around the policy rate (as in pre-2008).

Your remarks concerning Krugman’s willingness to engage are constructive. MMT may have to give an inch if it wants to capitalize on this longer term.

What you seem to be suggesting is that people decide to spend or not to spend based upon how they’ve decided to store their money? That’s backwards. People decide first whether to spend or store their money, and only then if they’ve decided to store it, do they decide HOW to store it.

But you seem to be going further. You’re saying that if they decide to store it, and their preferred storage vehicle is no longer available, they will simply decide to spend it instead. That’s ridiculous. They will look for the closest proxy to how they wanted to store it, and store it in the proxy instead.

” They will look for the closest proxy to how they wanted to store it, and store it in the proxy instead.”

We have to be careful here, because of the aggregation effects.

In my view the only substitution that will work is into what I call Fiat Money Things – which are essentially the Vertical Transactions mentioned in MMT, ie physical coins and notes, government bonds, or bank reserves.

For example if the nearest proxy is a bank deposit then the question moves onto what the bank does with its excess reserves. If the nearest proxy is a corporate bond then what does the corporate do with the money, or the secondary market participant selling the bond.

So if government bonds aren’t there as an option, then the Horizontal Transactions (consisting of Credit Money Things) will resolve in a slightly different way to what they would do if they were – until somebody somewhere is content to hold the Fiat Money Things that are actually available.

And the real question is whether those additional Horizontal Transactions involve any increase in consumption and if they do whether the economy can expand to absorb them without affecting prices.

Benedit, Neil, awesome comments, so nice to see people thinking along the same lines as myself.
Benedict we had a 100+ comment thread on this very blog about this:http://heteconomist.com/?p=2015&cpage=4#comment-5662
And Neil is totally right that there could still be nasty effects from people trying to save but unable in aggregate. I believe this effects are either small or go away with time, but monetarists have a point that monetary policy can prevent those (but risk other nasty effects in the future.)

And here is Cullen Roche’s response to Krugman’s latest arguments, which was posted prior to mine. A great discussion took place over at Pragmatic Capitalism. I should have noticed this before putting up my post and provided a link:

If I’ve missed any others, apologies. I’m struggling to keep up with the discussions at the moment, and also trying to catch up with previous ones.

Tom, thanks for chiming in regarding Neil’s question about the capital debates. I agree with your point. I will add that sometimes the problem is sidestepped by using highly restrictive assumptions (e.g. one capital good world), where the problems uncovered in the capital debates and by later general equilibrium theorists don’t arise. The results of these models are then appealed to on the basis that they provide insight to the real world, despite the restrictive assumptions. Or commentators, journalists and politicians simply assert things that only hold under such restrictive assumptions as if they applied more generally.

Speaking of Thoma, I just noticed this comment by Thoma (5/16/11) in response to Ralph Musgrave:

Ralph:

The nonsense is the MMT theory you have taken it upon yourself to spread all over the internet (MMT = “Modern” Monetary Theory, and it has been widely rejected for good reason). For those who are unaware, there is a very small but vocal group pushjing these ideas, and they have become louder and louder as their ideas have been ignored (for good reason, they don’t hold up to scrutiny — to the extent they add anything, it’s simply a restricted version of the standard model)

Further nonsense: The Treasury cannot print money — you discredit yourself by writing this. And Keynes had little faith in monetary policy in a recession in any case — see his “Many a slip twixt cup and lip” essay that makes exactly this point.

As for whether printing money causes inflation, I have argued again and again that it is only when the money turns into effective demand that it is inflationary — money piling up in bank vaults or in cookie jars does not. So the “dummy” here is the person making the false accusation abotu what I’ve said.

Does anyone know if this was discussed else where?

Thoma argues that:
1. MMT has been apparently rejected — I would love to read actual papers or blogs posts on this. From previous encounters with Thoma I assume he has Krugman’s posts in mind. He has previously mentioned that Krugman destroyed MMT. Obviously he is unaware of MMT literature to notice the strawman. But then he was unaware of SMD conditions too.

2. He believes that MMT is simply a special case (restricted version) of the IS-LM framework (reference to Nick Rowe’s post). This begs belief. the ISLM framework has been widely criticized in the Post Keynesian literature. From stock-flow inconsistency, to how it deals with expectations, historical time and equilibrium — you don’t have to look any further than Hicks (one of the contributors of the is-lm framework) for some strong criticisms against the model. But I guess being familiar with the literature which is outside your paradigm is too much to ask.

I’m dumbfounded by the number of times I’ve told my ‘neo-classical professors’ that Hick’s rejected the IS-LM model — referring to it as useful only as a class room cadget — and for my professors to have no idea. The same holds true for the SMD conditions, and Cambridge Capital controversies. The professors who are aware of these issues also respond “don’t worry, these issues are addressed in Post Grad”. Never mind the fact most students don’t continue onto post grad and never get exposed to this (assuming you actually do get exposed to it).

3. “Further nonsense: The Treasury cannot print money — you discredit yourself by writing this.”. If Thoma’s lecture’s are anything to go by, then Thoma is not familiar with treasury operations, and furthermore he is not familiar with what MMT’s are arguing. Here is obviously conflating a political constraint with a financial constraint. BTW watch lecture 14 on monetary policy to see what I mean about Thoma.

4. “As for whether printing money causes inflation, I have argued again and again that it is only when the money turns into effective demand that it is inflationary — money piling up in bank vaults or in cookie jars does not.”

If you watch his lecture 14 video he actually argues that printing money is inflationary (he shows this on an AD-AS model, with a vertical LRAS curve). But anyway that’s beside the point because in this instance he clearly is assuming that banks lend reserves — I doubt the money multiplier will ever be torn from their minds; It’s so easy to fall back on.

The engagements I’ve had with various professors, the content in most advanced macro course is just reinforcing my belief that I need to know further maths, a firm grasp of complexity theory, institutional structure of the economy, and the philosophy of science. But even then that’s doubtful, see for instance: Galbraith on the sociology of economic departments (http://www.youtube.com/watch?v=1yOdicriZ4k) and the numerous papers by Colander on issues such as DSGE and economics in general. I honestly’ can’t get over how insular the profession is.

Also, on the topic of how insular the economics profession is, follow the exchange between Thoma, Summers, Krugman and Baker on the topic of academic economists and economic practitioners. Despite the original argument by Thoma being that he was too confident in academic economists at the expense of economic practitioners, it quickly turned in an academic economists circle-jerk.

There is something very wrong with the way economics is taught, and the economy profession. I’ve found increasingly that if you ever bring up the question as to why the economic profession had no idea about the financial crisis, you’re quickly met with “heterodox economics is non-falsifiable”. A complete logical fallacy, because that has nothing to do with the original question, but what’s more worrying is how many seem to cling to this positivist notion of science, without any any sort of familiarity of what has gone on in the last 60 years in the philosophy of science.

Great comments, mdm. I can feel your pain at having to grit your teeth through years of attempted brainwashing in an economics program. Thanks for taking the time to express your thoughts so articulately.

I think it may be a good sign that Krugman, Thoma and others are feeling the need to respond.

The first step of the establishment, in this case the economic orthodoxy, is usually to ignore alternative approaches. If they can’t get away with that any longer – and they may feel it has got to that stage due to increasing exposure of MMT on the internet and likely questioning from students, journalists, etc. – they will try an appeal to authority and resort to vague straw-man dismissals. If this doesn’t work – and it won’t with anyone who has taken the time to study the approach – they will finally be forced to engage properly. Most of them are ill quipped to win if it gets this far due to the paucity of their own educations outside the orthodox approach. In contrast, heterodox economists typically have had to study orthodox theory in addition to their preferred approach. In most cases, it was the only way they could get their firsts, PhDs, etc.

But if the orthodoxy fails to engage seriously at this point, they lose anyway. They didn’t anticipate the crisis, nor the reasons for it; economists following some other approaches including Godley-influenced Post Keynesians, debt deflationists, Circuitistes, Modern Money Theorists and others did to a large extent. The orthodoxy didn’t have a good understanding of the best policies to approach the crisis once it hit (e.g. Krugman’s advocacy of QE measures); MMT economists and others, mainly Post Keynesians of various shades, did. Orthodox economists can back track and revise history all they like, but their collective failure is obvious to anyone who cares to look into the matter, and many will have been drawn to the subject with the onset of the crisis. Optimistically, there may be budding young economists drawn to the discipline for the right reasons, similar to in the aftermath of the Great Depression. If they are drawn to the discipline, there are several decades of published academic work to explore on MMT as well as a great deal of complementary research in the Post Keynesian tradition.

I still hold out some hope that someone such as Krugman, if he takes the time to examine MMT, will come around to it. I think many of his positions would be strengthened by adopting the approach. Or it may be that he has examined it, and won’t move until it becomes politic to do so. These guys have big reputations and a lot to lose. They need a face-saving way to make the transition. Something along the lines of, “Actually, what you are saying is basically what we’ve been saying all along. We just couldn’t understand each other because of an honest misunderstanding.” If someone like that moved across, it would become safer for others.

It is not impossible. High-profile economists with big reputations have admitted altering their positions in the past without damaging their reputations. Samuelson won his Nobel Prize in Economics shortly after the capital debates. Hicks, as you mentioned, rejected his IS/LM model later in his career. A bit of leadership from a high-profile economist could go a long way in effecting a broader transition.

Of course, if upon examining MMT they uncovered major problems, then no doubt they would publish such a legitimate critique. The fact they haven’t as yet suggests either that they have not examined the approach closely, or they have examined it without uncovering any serious weakness.

When someone offered to set up a debate with Bill Mitchell, to which Bill had already agreed, Thomas blew it off as ridiculous, saying that there was not point in debating with a person that rejected the money multiplier.

mdm: There is something very wrong with the way economics is taught, and the economy profession. I’ve found increasingly that if you ever bring up the question as to why the economic profession had no idea about the financial crisis, you’re quickly met with “heterodox economics is non-falsifiable”.

If they have not worked in finance, academic economists should be required to regularly trade a broad portfolio of foreign and domestic equities, debt instruments, currencies, commodities, and metals with enough of their own skin in the game to keep their attention focused sharply. Lacking this experience, most of them are just gassing.

What’s interesting is that the ‘weaknesses’ of MMT are clearly laid out:

– there’s no real evidence that firms will quantity expand rather than price expand. That’s an assumption – or an article of faith. Therefore any policy designed needs to have a contigency that deals with excessive price expansion if it happens.

– it relies upon the theory of floating exchange rates, and it is not clear that mechanism is sufficiently freely moving to provide the necessary degree of freedom allowing you to target inflation *and* unemployment. The effect of speculators, etc isn’t clear. As John Harvey says – it’s complicated.

– it doesn’t clearly determine what to do with supply side shocks, which may be caused by wild currency fluctuations brought on by carry trade activities. The real cost has to be distributed across the claimants. How best to do that?

– it doesn’t really address what to do with the banks and what level you need to control Credit expansion and contraction. How much is too much?

Neil, thanks for providing the link to Steve Keen’s lectures. Yes, I follow Steve’s blog and read the first edition of Debunking Economics a few years back. I first became aware of MMT as a result of the online discussion between Steve and Bill.

Good points, Neil. The difference is that MMT has a pretty good idea of where things will get complicated, why, and what tools are available to address issues as they arise.

The mainstream response to global crisis? “Who could have seen it coming?” And the mainstream is still trying unsuccessfully to deal with it based on lack of understanding and useless models.

Big difference.

BTW, I am a philosopher rather than an economist and when I first ran into economic reasoning as the mainstream practices it, I was shocked. A student presenting such loose and often clearly unsound reasoning would receive an F in Logic 101 — obvious stuff like reasoning from assumptions constructed to fit ideology rather than conform to fact, making logical jumps in generalizing from simple models, fallacies of composition, confirmation bias, willful ignorance of information relevant to issues, etc. Pretty basic stuff. But, hey, their math is correct.

You might find it interesting. It raises a number of issues about whether Post keynesian economics is coherent — it argues that it is methodological coherent due to its emphasis on open systems — and whether Post Keynesians should both to sit at the table with mainstream economics, which it argues it shouldn’t particularly considering how the mainstream manages to ignore the various criticisms, and it creates an image problem for Post Keynesians,because they are seen as a ‘negative’ research programme, and therefore not contributing anything to the science of economics.

Tom,

Can you recommend any books on the philosophy of science? Next year I will have a lecturer who is a positivist, who insists on the use of unrealistic assumptions and reductionism. As I understand it, the latter implicitly makes a number of ontological assumptions (i.e. a closed system, as a opposed to an open complex adaptive system). That part I should be able to handle, if I go through enough books on complexity economics, but I don’t feel confident enough to argue against the first two points.

What I don’t understand with the Strawman is how you run a 10% government deficit and yet still have excessive private sector loans (ie I > S) and no demand for bonds/currency from foreigners (implying X >= M).

Doesn’t that mean the sectors simply don’t add up?

Is there a set of numbers that fit Krugman’s description, or is he wrong on the basic accounting?

I don’t understand why everyone is vehement about Paul Krugman’s feature. If you think he doesn’t get it, or that he gets all wrong-not sure if there’s a difference, why bother at all. Whether we like it or not, we are recognizing that he’s a first class mind, or else we wouldn’t bother. So, to paraphrase the old rule of the thumb is: if a really bright guy misses something, either it’s our problem in not communicating properly, or we’re wrong!